Take The Red Pill: The Rise Of The Hybrid Startup

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Editor’s note: Glenn Kelman is the CEO of Redfin and formerly a co-founder of Plumtree Software. In this guest post he discusses the rise of the hybrid startup: with one foot in the virtual world, and one foot in the real. You can read his previous TechCrunch guest posts here.

Now there’s a second trend emerging in 2011 that seems at least as important: the hybrid business, with one foot in the virtual world and one foot in the real world. This isn’t the old “clicks-and-mortar” concept from the 1990s, which put web glitter on an old-school business, building Walmart.com for Walmart. A hybrid business is built entirely from scratch, to be innovative in its online technology and its real-world operations.

Redfin, for example, is a hybrid business: we couldn’t try to fundamentally change the real estate industry just by building a real estate website, so we also hired a team of our own real estate agents, paid on customer satisfaction rather than commissions, and trained to use technology to make home-buying more transparent. What we’ve learned is that being able to straddle virtual and physical worlds makes us far more powerful than any company confined to one or the other.

Do these companies seem unglamorous to you? Not to me. It’s hard not to be curious and delighted that former Twitter engineer Alex Payne is now co-founding a bank, which promises to be set apart as much by its corporate values and customer service as by its Android app. The reason everyone loves Square is that it involves an actual credit-card reader that you attach to your iPhone, the kind of gizmo that nobody except Steve Jobs or a Chinese manufacturer now considers building. Groupon is outpacing the revenues of local online guides because it has never been too squeamish or standoffish to hire thousands of sales people and copywriters to enroll coffeeshops in its deal-of-the-day promotions.

Even Amazon, which hid its telephone number for years to avoid talking to customers, now also has its own trucks that rumble down my street every Wednesday, delivering groceries, headphones, books, toys in reusable tote bags; every time I see one, I think Amazon is more likely to be around in 100 years than any other technology company we know today.

We’re used to thinking of competitive advantage coming from a Eureka-innovation like Google’s PageRank, but the most lasting advantage comes from a million incremental improvements in an operationally intensive business.

And there are thousands of opportunities to get operationally intensive. The entire real world is being dissected and tagged to become more intelligible to the virtual world: Redfin real estate agents are uploading photos of homes that they tour, banks are accepting images of checks in lieu of deposit slips, and restaurants are adding scannable bar codes to their menus so iPhone users can read more about the wine list. This is how technology will change life at the most intimate, local level.

Any Profitable Idea Scales
The conventional thinking has been that local, operationally intensive business don’t scale, because they don’t scale for free. As recently as this week’s New Yorker, James Surowiecki argued that the greatest new businesses, like YouTube and Twitter, are great because they “scale easily… growing very big without much effort.”

Surowiecki seems to have confused traffic with revenues, and speed with scale: glaciers move ponderously, but they shaped the face of the earth. Even where hybrid companies grow more slowly, venture investors have become increasingly tolerant of longer timeframes for large-scale opportunities, especially now that there is so much late-stage capital to keep everyone happy five years from founding.

And good things come to those who wait: Redfin can pay $20 million a year to hundreds of our local real estate agents, so long as we make $30 million from our customers. Once you establish profitable unit economics, you want as many units as you can get, regardless of each unit’s initial cost.

Focusing only on the $20 million in costs, not the $10 million in profits, early-stage investors value companies based on the percentage of revenues that fall to the bottom line. But what matters at the end of the day is the total number of dollars on the bottom line. Our attitude about profits should be as simple as Nikita Khrushchev’s when he was asked about the quality of Soviet tanks: “Quantity has a quality all its own.”

Go Where Other Technologists Dare Not Tread
The real objection many entrepreneurs have to hybrid businesses isn’t quantitative but qualitative. A friend of mind in technology used to love asking me, “So how do you like being a realtor now?” as if this were a horrible fate. A would-be competitor to Redfin abandoned the idea of selling houses directly after the co-founder found himself hanging a yard sign in a rain storm.

You see the same attitude in other industries: who in technology wants to work with retail bankers, teachers, doctors, restauranteurs? As a result, hybrid businesses have little or no competition: technology companies want nothing to do with the real world, and real-world companies struggle to develop competitive technology.

This divide prevents us from making things fundamentally better, or cheaper. The divide between the virtual and the real also prevents the basic ideology of Silicon Valley from reaching other professions. The Valley’s emphasis on empowering consumers and employees—on innovation, transparency, even idealism —isn’t just good for building software, it’s a universal good. There are thousands of bankers, realtors, doctors and lawyers who would love to practice their craft, but in a company run like Google. Our culture can be Silicon Valley’s second gift to the business world.

Data Dominance
In turn, the real world has a gift to offer the Valley: data. Companies that operate in the real world will always have direct access to data that purely virtual companies can only dream about. Redfin can build a better house-hunting website because we know when houses start getting bid up months before prices are recorded in county records.

Because customers meet us exclusively through our website, we also know which customers are the best match for us, before the customer ever meets an agent. This kind of analysis is far more important to us than it is to a purely virtual business: we have to pay for it every time an agent drives out to meet a customer at a house. The rest of the world, with its actual costs rather than just virtual opportunities, needs Silicon Valley’s ability to analyze massive data sets more than Silicon Valley does.

Customer Value
The final reason to operate in the real world is that people live in the real world, and the impact you can have on their lives there is much greater.

What if someone persuaded Jeff Bezos to skip the warehouses and the delivery trucks, building a purely digital business instead? What if Alex Payne helped start a lead-generation website for Citibank and JPMorgan, rather than his own bank service? What if Groupon decided that the copywriters and salespeople didn’t scale, letting local merchants develop their own deals? Margins would certainly be better, and operations would be much simpler, but, as we’ve argued before, Christmas shopping, banking & bargain-hunting would be much worse.

There is a similar opportunity in almost every industry: even as we speak, web entrepreneurs are teaming up with doctors to build better hospitals, with scientists to build better drugs, with lawyers to build better firms, with manufacturers to build better factories, with teachers to build better schools. We can make it new everywhere, not just on the web.